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Tag: GS 3 || Banking & Financial Sector || NBFC

Title: Credit needs to boost growth in India, Impact of Global Financial Crisis on Indian Economy

What is the issue?

 A significant portion of the Indian economy could grow a lot faster if its credit needs were better met.

Current credit scenario

 Unmet credit needs: Estimates of unmet credit needs of creditworthy Indian companies and small
entrepreneurs range from $500bn to $1tn compared to –
o India’s current GDP of about $2.8tn and
o total outstanding credit of about $1.8tn from scheduled commercial banks (SCBs), corporate bonds, and
HFCs/NBFCs.
 Closing this gap would clearly boost economic growth materially.
 Private sector leverage in India (as measured by total private credit to GDP) is a fraction of that in other large
economies, providing a long runway for growth in credit to support above-average economic growth.
o However, close attention has to be paid to managing the quality of credit growth and of the delivery
channel.

Recent credit crisis

 FY09-14: The vast majority of NPAs from the rapid FY09-14 credit growth was from very large projects with
lengthy durations for return of capital. Too much of banks’ balance sheets were utilised for large long-term
projects — a need generally best fulfilled by bond markets.
 RBI regulation: The period FY14-18 has been one of significant deleveraging (reduction in the leverage ratio of
banks, which is the percentage of debt
in the balance sheet) for SCBs, owing to
the RBI’s much-needed tightening of
norms for bad-loan recognition as well
as imposition of PCA on about half the
public sector banks.
  Bonds, HFCs: During the FY14-18 banking deleverage, initially bond
markets and HFCs/NBFCs filled some of the gap created and witnessed
strong growth. In 2018, bond issuance slowed down, driven by rising
yields, reducing issuer appetite.
o Subsequently, accelerating growth in credit from NBFCs/HFCs
encountered its own headwinds with September’s IL&FS
debacle.
o The commercial paper market dried up and several HFCs and
NBFCs had to sharply curtail disbursements.

Optimal credit share

 Private credit: The low penetration of private credit in India as a percentage of GDP suggests that all channels of
credit in India have tremendous potential to grow.
 What is the optimal mix for the growth between banks, bonds, HFCs, and NBFCs?
o As a proportion of GDP, bank credit is roughly the same in India and the US — the world’s broadest and
deepest capital market.
o However, total private credit is three times the proportion of GDP in the US relative to India.
 This suggests that the big gap between outstanding credit in the two countries is primarily in bonds and NBFCs,
and while credit from banks should continue to grow modestly faster than nominal GDP in India, it is bonds and
NBFCs that could grow significantly faster.

Challenges

 Shift the large project loans to corporate bonds: The dilemma for India currently appears to be on how to shift
large project loans away from banks to corporate bonds and thereby reduce asset-liability mismatch at banks
while getting banks to provide many more mid-size and smaller loans.

Way ahead

 MSMEs: The need is to enable credit growth to MSMEs (micro, small and medium enterprises), which provide
employment to 40 per cent of the workforce and contribute about 37 per cent of GDP.
o It is in this underserved market that the gap between demand for and supply of credit is the greatest.
o It is also in this market that key enablers (credit scores, formalisation of the economy, and the
emergence of HFCs and NBFCs as low-cost origination channels) have emerged to broaden credit access
while reducing risk and bringing down credit costs.
 MUDRA:
o The RBI’s threshold for classifying a company as an NBFC —
 financial assets comprising more than 50 per cent of total assets,
 income from financial assets constituting more than 50 per cent of gross income, and
 a minimum of ~2 crore of net own funds — appears low considering the well over 10,000
entities that qualify.
o However, the threshold is significantly higher for using MUDRA refinancing, with only those with an
investment grade rating and over ~15 crore as net own funds qualifying.
o Perhaps the authorities should revise the criteria for MUDRA to enable a broader selection of NBFCs to
qualify for refinancing MUDRA loans, particularly those that can better understand the needs of smaller
borrowers and also disburse loans with significantly lower execution cost.
 HFCs/NBFCs: On HFCs and NBFCs, the government and regulator need to take note of the changing landscape
 Also improving the collection and monitoring of data will enable more efficient growth in credit with fewer
restrictions.
o Monthly data reporting on sources of capital and on end-market credit exposure by size of loan, industry
and geography (state/UT) would help in mitigating potential build-up of unnecessary risk.
  Bonds: A significant boost to the depth and breadth of bond markets could come from broadening the choice of
bonds available to banks and insurance companies with ratings of up to a couple of notches below what is
currently permissible.
o Broadening the pool of potential buyers of bonds would likely boost the Indian corporate bond market
by a couple of years, and accelerate GDP growth.
 Regulation of NBFCs: What is also required is a more pragmatic approach from the government and regulator
on NBFCs as an origination channel for credit.
o While both government and regulators have been overly focused on the risks posed by unsupervised
growth of a sector that is not as regulated as banking, they have not optimised the use of a very low-
cost channel for expanding credit in the market while also diversifying the risk across a greater equity
base.
o In reality, the banking sector, even in its current structure of being dominated by the public sector,
would be a lot safer if there was an additional cushion of equity providing riskier credit to the
burgeoning demand for growth capital.

Additional Info

What is a Non-Banking Financial Company (NBFC)?

 A Non-Banking Financial Company (NBFC) is a company registered under the Companies Act, 1956 engaged in
the business of loans and advances, acquisition of shares/stocks/bonds/debentures/securities issued by
Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance
business, chit business but does not include any institution whose principal business is that of agriculture
activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and
sale/purchase/construction of immovable property.
 A non-banking institution which is a company and has principal business of receiving deposits under any scheme
or arrangement in one lump sum or in installments by way of contributions or in any other manner, is also a
non-banking financial company (Residuary non-banking company).

What is difference between banks & NBFCs?

 NBFCs lend and make investments and hence their activities are akin to that of banks; however there are a few
differences as given below:
i. NBFC cannot accept demand deposits;
ii. NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on
itself;
iii. deposit insurance facility of Deposit Insurance and Credit Guarantee Corporation is not available to
depositors of NBFCs, unlike in case of banks.

Mains question

 In view of the slowdown in bank lending and an aggregate increase in demand for credit, examine how the
NBFCs are instrumental in boosting the credit growth in the country.